Liberty. It’s a simple idea, but it’s also the linchpin of a complex system of values and practices: justice, prosperity, responsibility, toleration, cooperation, and peace. Many people believe that liberty is the core political value of modern civilization itself, the one that gives substance and form to all the other values of social life. They’re called libertarians.

Monday, July 23, 2012

HSBC Needs CEO Who Will Clean Up and Break Up the Bank

Bankers have made some dramatic
moves in recent years, but even the most cynical observers were
stunned last week when David Bagley, HSBC Holdings (HSBA) Plc’s top
compliance officer, resigned during a U.S. Senate hearing.
“As I have thought about the structural transformation of
the bank’s compliance function,” he told the senators, “I
recommended to the group that now is the appropriate time, for
me and for the bank, for someone new to serve as the head of
group compliance.”

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Simon Johnson, who served as chief economist at the International
Monetary Fund in 2007 and 2008, is a professor of entrepreneurship at
the Massachusetts Institute of Technology's Sloan School of Management.More about Simon Johnson

Translation: I am taking responsibility for the complete
failure of compliance on my watch.
The failure is indeed complete. Investigators working for
Democratic Senator Carl Levin of Michigan have established a
decade-long pattern of behavior in which HSBC, one of the
world’s largest banks, provided money-laundering services to
drug traffickers in Mexico and criminals around the world. The
bank also broke U.S. laws restricting transactions with Iran.
These were not isolated occurrences. No doubt some bank
employees had gone rogue, yet the problems went far beyond that,
including willful blindness by senior executives. The point of
compliance is to catch such behavior before it damages the brand
and threatens to bring down the company.

Management Failure

The bank’s management failed in this regard, and the buck
shouldn’t stop with Bagley. Chief Executive Officer Stuart Gulliver should take responsibility by stepping down. What’s
more, his successor should break the bank into more manageable
parts.
Something has gone very wrong on Gulliver’s watch. Why
would any responsible board of directors trust him to clean up
properly? Three arguments are being advanced for why he needn’t
resign; none is convincing.
First, it is suggested that HSBC didn’t lose much from this
scandal. The total fine is likely to amount to $1 billion (about
1/17th of last year’s profit). The bank’s shares fell only about
3 percent between when the news first broke and the July 17
hearing. Presumably, the market reaction was limited because the
bank’s U.S. and Latin American businesses account for less than
15 percent of operating profit.
How much damage has really been done, and how far does this
failure of compliance go? It is very hard to tell with a huge
bank like HSBC, and it would be wise to presume the worst. I
agree with Mike Mayo, a respected bank analyst at Credit
Agricole Securities, who said recently that large banks are
increasingly difficult to analyze, making it hard to know
whether they are good or bad investments. At this point, HSBC is
so out of control that breaking it up would be good for
shareholders. Who wants to invest in a bank where management
doesn’t know what is going on?
HSBC is also reported to be under investigation for fixing
benchmark interest rates, including the London interbank offered
rate, known as Libor, and its euro counterpart, Euribor. It is a
prominent member of 10 Libor panels. With the full scope of the
inquiries not yet known, might other legal disasters loom?
The second argument for keeping Gulliver is that he had
nothing to do with the bank’s Mexican business. There was a time
when CEOs took responsibility for major compliance failures.
Last September, for example, Oswald Gruebel stepped down as CEO
of Swiss bank UBS AG (UBSN) after unauthorized trading led to losses of
$2.3 billion.
Part of the CEO’s job is to make sure the company follows
the law. No one expects the top executive to be involved in
every transaction or to personally review every trading
position.

Highly Compensated

CEOs, however, are compensated highly because they are
supposed to make sure the proper systems are in place to avoid
illegal activity. (Gulliver’s 2011 compensation package, at 7.2
million pounds, or $11.3 million, touched off a political storm
in the U.K. over financial executives’ pay.)
Third, some commentators point out that HSBC is a global
bank not fully subject to U.S. or U.K. authorities. It has a
balance sheet of about $2.5 trillion (depending on whether you
follow U.S. or international accounting rules), or roughly the
same size as the British economy. It boasts of having about
300,000 employees serving 100 million customers out of 7,200
offices in 85 countries and territories around the world.
As such, HSBC is too big to fail. Executives speak of the
bank as being “backed by the balance sheet” of the U.K. and the
willingness of British taxpayers to provide bailouts (or not ask
too many questions when the political class arranges one). Any
illegal behavior that reduces shareholder capital -- a big fine
imposed by U.S. regulators, for example -- exposes the U.K.
taxpayer to greater risk.
Big banks benefit from large, opaque and dangerous
government subsidies. The subsidies are a form of crony
capitalism that should be ended, exactly as Jon Huntsman, the
former Republican presidential candidate, has suggested. These
banks should be broken up and made small enough to fail.
If the megabank continues to exist and the subsidies stay
in place, there is no market discipline that will constrain bad
behavior. Regulators must, in this case, prevent management from
behaving in a reckless manner.
The Bank of England and the U.K. Financial Services
Authority would be foolish to ignore what has happened at HSBC.
They should expect members of Parliament to take a keen
interest, particularly given the Libor scandal at Barclays Plc. (BARC)
An informed and focused public outcry can have a major
effect. Through the activities of HSBC, the British taxpayer has
been effectively enabling the dealings of Mexican drug cartels.
How can this not be a political scandal of the first order?
Gulliver has given no indication that he intends to resign.
Former Barclays CEO Bob Diamond was similarly defiant -- until
he was gone. His resignation was entirely appropriate. Diamond
presided over illegal behavior by Barclays’s staff. If he didn’t
know what they were doing, that just speaks to his inability to
be an effective CEO.
The U.K. taxpayer should demand the same outcome for
Gulliver. And the HSBC board should hire a replacement who
commits to creating value for shareholders by breaking up what
has become a too-big-to-manage bank